Peer to peer lending an alternative option to earn interest income

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Peer to peer (P2P) lending is the lending of money online directly to borrowers without the intermediation of a bank. In the traditional economy, a bank accepts deposits and gives out loans. In P2P lending, there is an online portal which plays the role of bringing together borrowers and lenders and enforcing certain standards. It does not accept deposits or make loans directly.

A few major peer to peer lending firms in India are:

Name

Year of launch

Lendbox

2015

Faircent

2013

i2ifunding

2015

How it works

In P2P lending, borrowers are typically funded by multiple lenders, thus reducing the risk of default. As a lender, you can also give out your money to multiple borrowers.

The interest rate is determined by the platform depending on the borrower’s requirements and background (as in Faircent) or it is determined through negotiations between the lender and the borrower (as in Lendbox).

There is also a third model (as in i2i Funding) in which the platform suggests an interest rate and the borrower decides whether to accept it or go with a different rate (however if the borrower’s rate is too low, lenders may not give him money). For example, if a borrower requires Rs 2 Lakh for a project, buying a home or for some commercial activity, they have to mention their requirements for the same. Based on the requirements, the interest rate that the borrower needs to pay will be decided.

Presently, peer to peer lending offers loans to individuals as well as businesses. However, there are more businesses accessing this kind of funding rather than individuals. Both lenders and borrowers pay a fee to use peer to peer lending.

The regulations

Earlier, P2P lending was not regulated. But recently, the RBI said that P2P lending platforms will be treated as non-banking financial companies (NBFC). NBFCs come under the purview of RBI. Those businesses who operate peer to peer lending have to obtain a certificate of registration. Also, those who are looking to register should have a minimum capital of Rs 2 crore.

Other regulations:

Lenders should not have exposure of more than Rs 10 lakh across all peer to peer lending platforms.

The exposure of a single lender to a single borrower should not be more than Rs 50,000.

The maximum loan tenure should be 36 months or less.

RBI has also said that all peer to peer lending fund transfers should be through escrow account mechanisms. Therefore, these transfers can be done only using bank accounts. RBI has strictly prohibited cash transactions.

The returns

Interest rates offered by P2P lending platforms to borrowers differ on a case by case basis. This means that the returns of investors will also differ based on the projects/requirements that they fund. Typically, P2P lending platforms such as i2ifunding and Lendbox offer returns of up to 15% – 30% per year.

The advantages

Since the process is done entirely online, it is easy for investors to participate.

One can start with as little as Rs 5,000 and earn more than what is offered for other products such as fixed deposits.

Usually, the P2P lending firm categorises borrowers into high-risk, medium-risk and low-risk ones. P2P lending firms use a borrower’s credit score, tax statements, bank statements and other documents to categorise them. You can choose a category based on your risk profile.

The Risks

Since P2P lending is not exactly formal like a bank loan, the risks of defaults are higher. This means that the borrower that you funded might not pay the interest or even worse, may not repay the loan. You might not get any returns if this happens.

How to lower risks?

Investors can lower their risks by choosing low-risk borrowers. As a lender, you can look at other factors such as the borrower’s job stability and whether they have any assets to decide whether to lend to them.

Some of the P2P lending firms (such as i2i) provide a ‘capital protection option’ to their investors. In this option, the platform typically guarantees a portion of your capital. You could look at this to reduce your risks.

Talk to other investors to find out how their experience has been. This will help you get an idea whether peer to peer lending is for you.

Most P2P lending firms provide you with monthly income. Don’t look at this as a substitute for salary or other income. You can rather look at reinvesting this income in safer avenues to protect it.

The taxation

The returns from peer to peer lending will be considered as ‘income from other sources’ and will be taxed as per your tax slab.

How-to

Register yourself as an investor with the P2P lending firm by providing basic KYC documents such as your PAN number.

You might have to pay some nominal fees to start lending money. Most of the times, you will need to link your bank account to your peer to peer lending account.

Choose from borrowers listed by the P2P lending firm.

You can then transfer funds to the borrower through the P2P lending website. You will start earning income as soon as the borrower starts paying interest on the amount.

P2P lending can be a great option to earn some income if you are ready for the risks.